TRACTOR SUPPLY CO quarterly report, Q2 FY2014

Tractor Supply Company: Fiscal 2014 Second-Quarter Form 10-Q

Business context and reporting period

Tractor Supply Company operates a single reportable segment selling products for the rural lifestyle, including livestock and pet, seasonal, hardware, agriculture, and clothing merchandise. The filing covers the fiscal quarter and six months ended June 28, 2014, compared with June 29, 2013. The company operated 1,331 stores at quarter-end, including 23 new stores opened during the quarter and 55 opened year-to-date.

Financial performance and condition

Metric	Q2 FY2014	Q2 FY2013	Change
Net sales	$1.584 billion	$1.456 billion	+8.8%
Gross profit	$550.5 million	$506.1 million	+8.8%
Gross margin	34.8%	34.8%	Flat
Operating income	$211.0 million	$198.0 million	+6.6%
Net income	$133.4 million	$123.6 million	+8.0%
Diluted EPS	$0.95	$0.87	+9.2%

First-half net sales increased 8.9% to $2.768 billion; net income increased 8.7% to $182.2 million; diluted EPS increased to $1.30 from $1.18.
First-half gross margin was 34.2%, up from 33.8%. SG&A and depreciation as a percentage of sales increased to 23.7% from 23.4%; second-quarter SG&A and depreciation increased to 21.5% from 21.2%.
Comparable-store sales increased 1.9% in the quarter and 2.0% for the first six months. New-store sales contributed 6.9 percentage points of quarterly sales growth and 6.8 percentage points of first-half growth.
Cash provided by operating activities was $166.5 million for the first six months, versus $62.8 million in the prior-year period. Capital expenditures were $82.1 million, compared with $98.6 million.
Cash and cash equivalents were $56.0 million at June 28, 2014, compared with $142.7 million at December 28, 2013. Inventory was $1.155 billion, up $175.3 million from year-end, primarily for seasonal requirements and new-store growth.
Working capital was $655.2 million. Total liabilities were $759.6 million and stockholders’ equity was $1.266 billion.
The company had no borrowings under its Senior Credit Facility. Availability was increased from $250 million to $400 million, with maturity in October 2016; outstanding letters of credit totaled $70.9 million under the facility and $18.3 million outside it.

Material changes versus the prior comparable period

Sales growth reflected 1.9% comparable-store growth and continued store expansion, but comparable growth slowed from 7.2% in the prior-year quarter and 4.2% in the prior-year first half.
Management estimated deflation reduced comparable sales by approximately 100 basis points in the quarter and 90 basis points year-to-date, principally in livestock feed and bird-feeding products.
Quarterly gross margin was unchanged because transportation costs, product mix, and increased sales-driving promotions offset gross-margin initiatives and deflation benefits. First-half gross margin improved 40 basis points.
Higher employee benefit expenses, new-store growth, variable operating costs, extreme cold-weather costs, and distribution-center costs increased SG&A as a percentage of sales.
Financing cash use increased to $171.3 million from $55.8 million, primarily because share repurchases rose to $147.0 million from $69.3 million and dividends paid increased to $40.3 million from $32.1 million.

Guidance, outlook, risks, contingencies, and unusual items

Management expected to open approximately 102 to 106 new stores in fiscal 2014, compared with 102 in fiscal 2013, and expected the new store support center to be completed in the third quarter of fiscal 2014.
Management expected a full-year 2014 effective tax rate of approximately 36.9%. The first-half rate increased slightly because the federal Wage Opportunity Tax Credit had not been reinstated.
Management stated that cash balances, operating cash flow, credit availability, leases, and trade credit should fund operations and capital needs through the end of fiscal 2014.
The board increased total share-repurchase authorization to $2.0 billion through December 2017. The company repurchased 2.2 million shares for $147.0 million during the first half, with approximately $1.01 billion remaining.
The company declared a quarterly dividend of $0.16 per share payable September 3, 2014. Future dividends remain subject to board discretion.
The business is seasonal and exposed to weather, consumer spending, product and transportation cost volatility, competition, store expansion execution, foreign suppliers, employee retention, information-system disruptions, regulatory changes, tax matters, and legal claims.
The company is in settlement discussions with the DOJ and EPA concerning alleged Clean Air Act violations involving certain imported engines. Management does not expect a material adverse effect and does not believe losses in excess of accrued amounts are reasonably possible.
Net self-insurance reserves were $43.9 million at June 28, 2014. Management noted that adverse claim experience could materially affect results.
FASB ASU 2014-09, Revenue from Contracts with Customers, will apply for periods beginning after December 15, 2016; management was assessing its impact and transition method.

Important facts for investors to verify

Whether comparable-store sales and seasonal merchandise performance improve after the quarter’s slowdown and weather-related softness.
The sustainability of gross-margin gains given deflation, transportation costs, promotions, and product mix.
Inventory growth, seasonal working-capital requirements, and the extent to which operating cash flow was aided by the timing of income-tax payments.
The pace, returns, and funding requirements of the planned 102–106 new-store openings and the new store support center.
The effect of substantial share repurchases and dividends on cash balances and future liquidity.
Compliance with credit-facility covenants, letters-of-credit obligations, and the availability of unused borrowing capacity.
The ultimate cost and timing of the EPA/DOJ matter, self-insurance claims, and other litigation or regulatory contingencies.